If you take advantage of your employer's health insurance plan, or have contributions to your 401(k) or flexible spending account deducted directly from your paycheck, then employers are taking the funds from your pretax earnings. Your employer may even encourage you to make charitable gifts through payroll deductions, but each donation is taken after-tax. The after-tax charitable donations, however, are deductible when you file your return.
Difference Between Pretax and After-Tax
When an amount is withheld from your paycheck on a pretax basis, it means the money isn't subject to income tax, isn't included on your W-2 as wages and may reduce the tax withholding on your salary. In contrast, an after-tax deduction is taken from your net pay -- meaning your employer first withholds all required taxes and then takes the money out of the remaining funds. An after-tax payroll deduction, such as for charitable donations, doesn't reduce the amount reported on your W-2 and is reported as income on your tax returns. For example, if you earn an annual salary of $40,000 and request that your employer withhold $500 for your health savings account and $250 for a United Way donation, your W-2 will report $39,500 of taxable wages.
Writing Off Charitable Payroll Donations
Because your charitable donations come out of your after-tax earnings, you can deduct the total amount deducted from your payroll checks during the year on the “Gifts to Charity” line of your Schedule A if you choose to itemize instead of claiming the standard deduction. If your employer matches your payroll donation, you can't deduct any of the matched donation -- only your employer can deduct that portion of the charitable gift.
When Itemizing Deductions Is Beneficial
Every year, you have the choice of claiming the standard deduction for your filing status or to itemize specific expenses, such as charitable donations, on Schedule A. Itemizing is beneficial when doing so gives you a larger write-off than the standard deduction offers. You can figure this out by completing a Schedule A to see what your total itemized deductions are. In addition to the donations you make through payroll deductions, itemized expenses include other charitable gifts, property taxes, mortgage interest, a portion of your medical and dental expenses, state and local income taxes, and a number of other expenses.
Records That Support Your Deduction
The Internal Revenue Service doesn't want you to attach every pay stub to your tax return, but it does require that you retain records that support your charitable deduction. For your payroll donations, you must hold on to pay stubs, your W-2 form or a document prepared by your employer that lists the details of each donation. In addition, the IRS requires that you retain a pledge card that's prepared by or for the charity that has the organization's name on it. And if any single payroll deduction is $250 or more, your records must include the date on which each of these large donations was made. Because the IRS only has three years to audit your return, it may not be necessary to retain the records beyond this time frame.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.